The Fed War: Yellen Doctrine vs. Volcker Doctrine

by Ralph Benko

The financial markets are on a hair trigger as to when, and how quickly, the Fed will tighten and raise interest rates. Billions of dollars will be won or lost by investors on this wager. For the rest of us, getting it right — as did Chairman Volcker and (during his first two terms), Greenspan is crucial to the creation of a climate of equitable prosperity in which jobs are created in abundance. 39 million jobs were created during the “Great Moderation.” We haven’t seen anything remotely like that since.

Getting it right is crucial to economic mobility — raises, bonuses, and promotions — to let us workers climb the ladder to decent affluence. Thus, just when to raise rates is much less important than the bedrock issue.

For over a decade now job creation has been poor. Poor, too, has been economic mobility. The left is very much on record as calling for extended ease — keeping interest rates down. The right has been critical over the Fed’s “zero interest rate policy.” Yet the real tug of war is over whether the Fed should follow a monetary rule or exercise discretion; and, if a rule is preferable, what rule?

Yellen has been on a campaign to demonstrate her empathy with workers. Less well known: this empathy is shared by many conservatives and libertarians. I, among others, find Yellen’s new openness to rank and file workers and activists a refreshing change of tone from that of the formerly hermetically sealed “Temple.” There are few matters on which I agree on with Sen. Sherrod Brown. This is one of them. As Sen. Brown told Politico:

“I love that Chair Yellen and three Fed governors actually had public meetings,” said Sen. Sherrod Brown of Ohio, an outspoken member of the Senate Democrats’ liberal wing, commending Yellen and her colleagues for recently meeting with progressive activists. “She wants to set a different tone there where they’re listening to the public and listening to people who have lost jobs, listening to people who have seen their life savings evaporate….

Yellen’s descent from Temple Mount to we plain people of the plane is a notable shift. It well accords, at least in style and possibly in substance, with the new populist spirit abroad in the land. It is imperative, however, that it prove substantive and not merely cosmetic. And substantive means an intellectual openness to a diversity of views.

The right is not the party of Ebenezer Scrooge. The right is all for job creation and a rising tide lifting all boats. Yet Yellen has been connecting, so far exclusively, with the left. In her first year, Yellen visited a trade school and donned a welding mask (a terrific photo op, truly); toured a low income neighborhood before speaking, to wide note, at a Boston Fed conference where she advocated for the social safety net and social services (notably, mysteriously, not speaking about monetary policy); met with President Obama on the eve of the 2014 election; and recently took an unprecedented meeting with what Bloomberg.com called “labor and community organizers.”

It is my guess that Janet Yellen reaches out to the social-democratic left because it represents her native intellectual milieu. They speak her language. Many progressives simply find the right foreign, our language alien. (Memo to Yellen: If all I knew about my team was what I read from Paul Krugman I, too, would disdain me. The mainstream media portrayal of the right is a grotesque caricature. We’re not the way we are portrayed. We are, however, skeptical of the efficacy of central planning. For good reason. And, Dr. Yellen? America is a center right nation.)

Soon we shall stop guessing and find out if Janet Yellen truly is open to hearing a diversity of views … or whether this really is merely a “charm campaign.” One of the leading monetary integrity advocacy groups (and the lead gold standard advocacy group) on the center right, American Principles in Action, which I professionally advise, recently hand-delivered to the Fed a request to Madam Yellen that she meet with representatives of the right.

The letter, signed by 20 high profile figures on the right, stated:

This is to endorse the pending request by American Principles in Action’s Steve Lonegan for a meeting with you, Vice Chair Fischer, and others of your selection, to gather and exchange views with a delegation of monetary policy thought leaders from the center-right.

…

The left by no means has a monopoly on concern for unemployment and wage stagnation. To balance a meeting with a group composed of, as described by Bloomberg News, “labor and community organizers” with one of the leading representatives of the center right experts would honor that principle of “a diversity of views”. An evenhanded insight on achieving our shared goal of job creation and economic mobility would facilitate steps toward realization of this mutual objective.

The letter is noteworthy and may portend a significant shift in the discourse. The “money quote:” “The left by no means has a monopoly on concern for unemployment and wage stagnation.” This is a thematic development that Yellen would do well to encourage. The difference between members of the humanitarian left and humanitarian right is one of means, not ends.

All agree that money matters, and that the Fed is the fulcrum of the world’s monetary system. The left believes that discretion is the recipe for more equitable prosperity. The right believes that a monetary rule will yield greater equitable prosperity. Both cannot be right. Yet this is, and should be treated as, an empirical, not doctrinal, matter. It is not, at heart, a “left vs. right” issue.

In a way, it’s “Yellen vs. Volcker.” Contrast a statement by Madam Yellen with one made by former (and iconic author of the Great Moderation) Fed Chairman Paul Volcker, reprised in an earlier column:

Madame Yellen [at hearing of the House Financial Services Committee chaired by Chairman Jeb Hensarling earlier this year] stated that “It would be a grave mistake for the Fed to commit to conduct monetary policy according to a mathematical rule.” Contrast Madame Yellen’s protest with a recent speech by Paul Volcker in which he forthrightly stated: “By now I think we can agree that the absence of an official, rules-based cooperatively managed, monetary system has not been a great success. In fact, international financial crises seem at least as frequent and more destructive in impeding economic stability and growth. … Not a pretty picture.”

Not all rules are mathematical. There may be room for agreement implicit in Yellen’s statement.

There is no generic rule. And a bad rule, or a rule badly implemented, could be worse than no rule at all. If a rule is to be preferred, which rule?

There are contending schools of thought. These prominently include the Taylor Rule, NGDP targeting, inflation targeting, commodity price targeting, and the gold standard. Of the latter, Paul Volcker, not himself a proponent of the gold standard, once had this to say in his Foreword to Marjorie Deane and Robert Pringle’s The Central Banks (Hamish Hamilton, 1994):

It is a sobering fact that the prominence of central banks in this century has coincided with a general tendency towards more inflation, not less. By and large, if the overriding objective is price stability, we did better with the nineteenth-century gold standard and passive central banks, with currency boards, or even with ‘free banking.’

Which rule would most likely be optimal for fomenting equitable prosperity as well as price stability? Each regime has eloquent advocates.

It is, in fact, an open question.

Thus the safest path forward out of the uncharted territory in which we find ourselves appears to be the proposed Brady-Cornyn monetary commission introduced in the 113th Congress. It reportedly is certain to be re-introduced in the 114th.

The proposed commission, widely praised in the financial media, is designed to be strictly bipartisan and meticulously empirical. It is chartered to make an objective assessment of the real outcomes of the various rules now being propounded. While many commissions are designed to derail an issue, a monetary commission would be very much in order. Monetary policy is intricate and potent, not amenable to political towel-snapping-as-usual.

This proposed commission is not in at all inimical to the Fed. The Fed Chair gets an appointment of an ex-officio Commissioner to ensure that the monetary authorities have a dignified voice in the review process. The Treasury Secretary gets to appoint an ex-officio commissioner as well.

Politico has termed Yellen’s the “Toughest job in Washington.” This surely is apt. In taking a step away from her crystal ball and connecting with the rank and file Janet Yellen may have unleashed a healthy dynamic that could prove beneficial to making progress. But only if she listens to all sides. Moreover, the Commission would provide a civil buffer from the sobering reality that, as Politico reported, “Republican leaders and staff said in interviews that they plan to use their new dominance on both sides of Capitol Hill next year to target the Fed for much greater scrutiny, including aggressive hearings ….”

On the surface it’s a tug of war between raising and lowering interest rates. At root, it’s an argument about whether the Fed should be following a rule or making one up as it goes along. If Yellen proves open to a diversity of viewpoints, and if the Fed puts its benediction on the Brady-Cornyn monetary commission legislation, 2015 well could see the beginning of a move in the direction of credit both affordable and abundant that could rival for job creation the Great Moderation.